Wednesday, November 11, 2009

A Jobless Recovery

Copyright, The New York Times Company
The Bureau of Economic Analysis recently confirmed what everyone suspected, that real spending and incomes grew again from the second to the third quarters of this year. Yet we also learned on Friday that employment still fell in October, as it had in previous months. Although employment will someday turn upward, I suspect that this divergent pattern for spending and employment will continue for a while.

One bit of conventional wisdom about this recession is that it was caused, or at least significantly worsened, by a paradox of thrift: Consumers suddenly ceased to be willing or able to spend as they once did. But I have argued against that conventional wisdom, based in part on the fact that work hours and employment have fallen much more than either consumer spending or personal incomes have.

Indeed, real personal consumption expenditure was higher in September 2009 than it was a year earlier (as was real personal disposable income), while work hours had fallen 7 percent. This recession cannot be understood merely as the consequence of low spending.

A variety of models can help explain the recession so far, and to predict where it may be going, but here I’d like to focus on the two variables emphasized in my own research: productivity, and what are known as labor market distortions.

Productivity is the amount produced per hour worked. If productivity grows, it means that output can grow faster than employment, as it did from the second to the third quarter.

During several previous recessions, productivity was falling. Yet this recession has been different, with productivity throughout 2008 and 2009 being higher than it was when the recession got started.

Productivity growth has been especially strong during the last two quarters, perhaps in part a recovery from somewhat slower (but still positive) productivity growth at the end of 2008. Productivity could surge a bit more — maybe for another quarter — without exceeding the long-term trend. If so, inflation-adjusted output would continue to grow faster than employment and hours over the next couple of quarters.

Labor market distortions are a collection of factors that hold back employment, even when employees are creating a lot of value.

These distortions include difficulties in job search, income taxes, minimum-wage laws and incentives that are eroded by means-tested government benefits (determining whether someone should receive benefits based on things like the person’s income). These factors can be difficult to quantify individually, but we know from the poor employment results that at least some of them are important.

Labor market distortions have gotten progressively worse during this recession. The federal minimum wage, for example, was increased once shortly before the recession began, a second time in the summer of 2008, and yet again this summer. The housing collapse has also had multiple harmful effects, such as impeding families who might want to move out of some of the hardest-hit regions toward areas where the economy is doing better.

These types of factors can make a bad labor market much worse.

Some of the labor market distortions will stop getting worse over the next couple of months, as housing prices stabilize and the federal minimum wage stays put, but that does not mean that labor market problems will reverse themselves.

According to my measures, labor market distortions have been getting worse at the same rate over the past couple of months as they have throughout the overall recession. Moreover, Congress appears poised to further erode incentives to earn income as an accidental byproduct of its plans reforming health care. Nor do consumers seem to be spending in anticipation of a grand employment recovery.

Thus, my humble prediction for the next several months is that real incomes and spending will continue to grow, although likely at an annual pace less than the 3.5 percent estimated a couple of weeks ago. In other words, as many have feared, this part of the recovery will be “jobless,” in the sense that employment and hours will not rise significantly, and may continue to fall.

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